Canadian business people are in for “many sleepless nights” following a Federal Court ruling that public companies must disclose the reserves they take for contingent tax liabilities — that is, amounts of extra tax they might have to pay if the Canada Revenue Agency challenges parts of their tax returns.

Essentially, the court decision requires businesses to provide the CRA with the ammunition to challenge tax returns.

“The decision of the Federal Court in Minister of National Revenue v. BP Canada Energy Company is one that is likely to reverberate throughout the corridors of the Canadian business community for a long time,” says tax expert William Innes of Rueter Scargall Bennett. “This is a decision that will likely make its way to the Supreme Court of Canada and until it does it is almost certain to give the Canadian business community many sleepless nights.”

To comply with their reporting obligations, public companies’ consolidated financial statements must calculate reserves to account for contingent tax liabilities, including an estimate of the liability the company and its subsidiaries would face if the Canada Revenue Agency challenged uncertain positions in the tax returns. The calculations are supported by working papers that identify the issues that the company knows might be subject to challenge. These are known as “Issues Lists” and represent the areas at highest risk for loss of tax revenue.

Historically, CRA has not sought production of the Issues Lists while conducting audits of corporations. But in May 2010, the government effected a policy change requiring production of “tax accrual working papers,” including those relating to reserves for contingent tax liabilities. The policy stated that these documents were “not routinely required” but that officials “may request” them.

During the course of an audit of BP Canada, the company redacted the Issues Lists from responses to CRA inquiries. CRA brought a motion to compel production of the redactions. There was no evidence that CRA had special concerns that led to the request: its position before the Court was that it sought the Issues List “no matter what.” The Agency’s, however, also justified the request as “required to verify whether BP’s uncertain tax positions are compliant with the [Income Tax] Act.

On June 5, in a decision not yet posted on the Court’s website, the Court ordered production, dismissing BP Canada’s lengthy arguments as having no merit.